Revenue Reconciliation Act of 1993

On August 10, 1993, President Clinton signed the Revenue Reconciliation Act of 1933 (RRA 93). This law, intended to reduce the deficit through increasing revenues, hits almost every taxpayer. This legislation seems to fly directly in the face of the Tax Reform Act of 1986, which reduced marginal tax brackets and eliminated the tax difference between ordinary income and capital gains - which in turn minimized the benefit of most tax-planning strategies.

RRA 93 has returned taxpayers to higher marginal tax brackets, in some cases as high as 40.79%, while the capital gains rate has remained at 28%. Large tax increases will fall upon those earning over $180,000, and many seniors will experience sharp tax increases by the inclusion of 85% of social security benefits now deemed taxable income. In fact, motivated citizens can find - and expeditiously exploit - the disparity among marginal tax brackets by converting ordinary income into capital gains and by shifting income to lower-bracket family members. As Yogi Berra quipped, "It's deja vu, all over again!"

New Tax Brackets

RRA 93 created two new tax brackets:

a 36% tax bracket for taxable incomes of $140,000 for joint filers, and $115,000 for individuals; and
a 39.6% tax bracket for both joint and individual filers through a 10% surcharge on taxable incomes over $250,000. Also, the current $135,000 cap on Medicare taxes has been removed, creating an additional 2.9% tax (paid half by the employee) on all earned income. The 3% phaseout for itemized deductions and 2% phaseout for personal and dependency exemptions are now permanent.

Seniors must include 85% of their social security benefits as income for those with "provisional" incomes over $44,000 for joint filers and $34,000 for individuals. Provisional income is - generally - adjusted gross income, plus tax-exempt income, plus 50% of social security benefits.

Tax Planning Opportunities

Convert ordinary income into capital gains and invest in tax-free bonds: The rate for long-term capital gains for assets held longer than one year remains at 28%, while earned income over $250,000 will be taxed at 39.6%. Therefore, taxpayers should attempt to convert ordinary income into capital gains. Invest in stocks with low dividends and high appreciation, acquire incentive stock options at work, and structure the sale of real property or businesses to increase capital gains. Also consider tax-exempt bonds.
Increase debt and maximize retirement plan contributions: The mortgage interest deduction for first and second homes, and the $100,000 home-equity interest deduction remain intact. Obtain an home-equity loan and pay down non-deductible interest on items such as credit cards and auto loans. Acquire a second home. Maximize contributions to tax-deferred retirement plans (401(k) plans). Set up and contribute to an IRA or SEP IRA. Self-employed individuals must open Keogh plans before year's end.
Consider converting an "S" corporation into a "C" corporation: Since tax brackets for "C" corporations have remained intact for taxable incomes under $100,000, shareholders in an "S" corporation receiving distributions over $300,000 might consider converting the corporation into a "C" corporation.
Divide up large payments: Instead of receiving a large, lump-sum payment, consider spreading out that income over several years, thereby avoiding the higher tax brackets. For instance, if a taxpayer with $150,000 taxable income receives a single payment of $500,000, then $400,000 of the lump-sum payment will be exposed to the 39.6% tax bracket. By dividing this income evenly over five years, none of it will be taxed at the 39.6% bracket.
Make charitable gifts of appreciated property: There is tax break for those making charitable donations of appreciated real and personal property. The full value of the donation is now deductible under both the regular tax system and the alternative minimum tax regime. Therefore, a taxpayer who acquired a painting for $1,000 that is now worth $150,000 will receive a charitable deduction of $150,000.
Do not get married!: RRA 93 contains a substantial marriage penalty for high-income taxpayers who get married. If two individuals each with taxable incomes of $250,000 get married, 50% of their taxable income will be subject to the 39.6% bracket. If they remain single, none of their income will be taxed at 39.6%. Also, if two seniors with provisional incomes of $34,000 get married, then all of their social security benefits will probably be included at the 85% rate. If they remain single, then none of their benefits will be included at the 85% rate.

All contents copyright © 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.